Facing Distribution Challenges in China

Western companies are so accustomed to viewing China as a competitor that it's easy to forget China is a customer of many US and EU-based technology businesses. Global corporations often get slammed for moving operations to the Far East, but as General Electric CEO Jeff Immelt has said, a publicly traded company would be doing its shareholders a disservice if it didn't have a presence in the largest consumer market in the world.

Even after decades of operating in China, Western businesses still find the environment challenging. In many ways, customers in the region are the same: they want an efficient, cost-efficient supply chain. When China-based OEMs were asked by UPS/IDG what their pain points were, the responses in the white paper “Asia Change in the Chain” looked very familiar:

    When respondents were asked about weak links or persistent pain points in their supply chains, risk management, managing inventory, and end-to-end visibility were listed most frequently.

These are the same issues cited by companies that don't have a significant presence in China. Yet China's vast geography, business practices, and culture aren't always a good fit with Western supply chain practices.

End-to-end visibility seems to be particularly elusive. Part of that challenge is the structure of the supply chain itself. Information has to pass through a lot of stopping points between design and manufacturing in electronics. A seemingly simple matter — tracking a device throughout that process — is a classic example.

Typically, a distributor will assist a supplier by getting its device designed into an end-product. The design, prototyping, and bill of materials (BOM) rationalization are usually done in one location — for example, Dallas. The OEM decides to use an electronics manufacturing services (EMS) provider in Shenzhen to manufacture the end product. Numerous disruptions can occur. A single component might not make it to the factory floor and delay production. In order to minimize the loss from idle manufacturing lines, an alternate part might be used by the EMS provider. The substitution information may not be sent back to the supplier and distributor — or be sent too late to make any difference.

The effects of this simple move then expand exponentially. Suppliers build products based on distributor and customer forecasts. A last-minute swap usually means suppliers have already manufactured their devices. The original supplier may end up with excess inventory while the alternative supplier's stock runs low. According to UPS/IDG, Asian manufacturers say:

    Inventory is often poorly managed — either there is far too much across the extended supply chain or it performs poorly (the wrong things in the wrong places, or significant obsolete stock).

There's another challenge in China that doesn't occur as frequently in the EU and US: concern about IP. What an OEM designs into its product reveals a lot about the product itself. Pricing information is also shared throughout the supply chain. China does not view IP as something private or unique: at best, it's public property; at worst, it can be exploited to deliver a knock-off. According to UPS/IDG, visibility in China is on a “need-to-know” basis:

    Visibility remains elusive for most companies, usually because it has been viewed as a non-cost-justifiable blue-sky vision. Recent progress across manufacturing has been made by viewing visibility in the context of specific use cases such as supply chain traceability or supply interruptions.

Failure in these two issues — visibility and inventory management — has an effect on sales. Suppliers whose products are designed into a product expect large production orders will be placed. Distributors that assist in the design get compensated through these orders in the form of a higher profit margins or preferred pricing. If the orders don't materialize for one reason or another, suppliers and distributors both lose sales.

There is also a scenario in which the supplier benefits but the distributor does not. If a device can't be delivered by Distributor A, OEM/EMS companies may turn to Distributor B. Either way, the supplier sells its product, but its distribution relationship may be strained.

Distributors that are headquartered in the West tread lightly when it comes to imprinting their practices in the Far East. Broadline distributors, which sell a wide variety of components, aren't the norm in China. Components makers in that region are often aligned with smaller firm that resell only a few product lines. The one-stop shop model that works well for OEMs in the US and EU may not be possible overseas. As a result, OEMs and EMS companies engage with numerous partners in China to fulfill a bill of material.

It's likely that China will begin to move more toward Western practices for a single reason: cost. As wages and other costs go up in China, companies will seek more efficiency such as paring down their supplier line cards. In upcoming posts, I'll look at other challenges and possible solutions to supply chain complexity in China.

8 comments on “Facing Distribution Challenges in China

  1. bolaji ojo
    November 15, 2012

    Barbara, Distributors have gingerly handled China and continue to do this even now but there are many issues and challenges yet to be resolved for the industry in that country. Many of these will come up and they will have to confront these eventually. The status quo today cannot work for everyone. I believe a tough distribution leader will emerge soon to boldly outline the challenges, issues and solutions. This hasn't happened so far but this industry has confronted major challenges before and will do this again with regard to the big Chinese market.

  2. Taimoor Zubar
    November 15, 2012

    “Western companies are so accustomed to viewing China as a competitor that it's easy to forget China is a customer of many US and EU-based technology businesses.”

    @Barbara: I've read it at several places (including on EBN blogs/comments) that apart from the cost advantage one of the main reasons of manufacturing in China is that there's a large population with good income levels who can afford to buy the products. There's very little shipping cost involved in selling to these customers. I think a lot of companies do consider Chinese as consumers too when they're devising their strategies.

  3. Taimoor Zubar
    November 15, 2012

    @Barbara: What do you think of the role Chinese government is playing in this case? Do they encourage foreign companies to come and sell into China? Are they still very conservative about it?

  4. Barbara Jorgensen
    November 15, 2012

    @Taimoor: I don't think China's government has a unique approach to the supply chain: all of the same issues apply to everyone. There are value-added taxes that are confusing; there are import/export laws that favor indigenous companies, and in general, China's practices are skewed favorably toward China. The supply chain may have more challenges becuase so much product moves around inside and outside the country, but I don't think the government pays specific attention to distribution.

  5. ahdand
    November 16, 2012

    China is making things complicated from not allowing US companies to get into the market in China. Its them who get things dragged on unwatntedly and it will definitely hit their economy in the near future.

  6. garyk
    November 16, 2012

    Forget the share holders, they can receive lower profits. What about the US? If the US can't afford to purchase the products, who is going to buy them? India. Mexico, CHINA, Europe?. Exports are down in CHINA? There are laying off workers, Oh, thats right they don't need workers they have robots! The robots can buy the products made in CHINA.

  7. Barbara Jorgensen
    November 16, 2012

    @garyk: It's been interesting that in covering distribution I have dealt with private and public companies. The private companies invest when things get challenging and the public companies cut costs. I'm not sure “forgetting shareholders” is an option for public companies. And it's hard to imagine that China is already so close to Western costs that there isn't an advantage there.

  8. garyk
    November 16, 2012

    If costs are the same why are company's moving to CHINA? Quality of Engineering, company's are able to build a factory over night, government supports building factory's, who is building the factory's in CHINA (FOXCONN)? Is the Government of CHINA building the factory's, is CHINA saying if you build your factory in CHINA we won't compete againist you. Think about this, 100 Christmas lights for $1.98? Golf Driver $400-$600 made in CHINA assembled in US, who is making the porfit? ( the company TaylorMade and the stock holders. not the golfer.

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